The setting of prices of consumer products or services is one of the most important decisions a business enterprise is faced with. The price of a product or service is one of the main factors that determines the willingness of a consumer to purchase it, thus having a significant influence on the business performance of an enterprise. Nevertheless, a methodological approach for setting prices is seldom encountered in enterprises.
A standard practice in enterprises is to add a fixed gross margin to the cost of a product or service, without segmenting customers according to their willingness to pay. It is also possible to charge an optimal price according to the demand function of each customer. In this way, the same product or service could be offered to different customers at different prices. Such segmented marketing is not often used for consumer products but is quite frequent in large scale and business to business transactions.
U.S. Pat. No. 6,078,893 discloses a method for tuning a demand model in a manner that is stable with respect to fluctuations in the sales history used for the tuning. A market model is selected, which predicts how a subset of the parameters in the demand model depends upon information external to the sales history; this model may itself have a number of parameters. An effective figure-of-merit function is defined, consisting of a standard figure-of-merit function based upon the demand model and the sales history, plus a function that attains a minimum value when the parameters of the demand model are closest to the predictions of the market model. This effective figure-of-merit function is minimized with respect to the demand model and market model parameters. The resulting demand model parameters conform to the portions of the sales history data that show a strong trend, and conform to the external market information when the corresponding portions of the sales history data show noise.
Certain consumer products are generally customized. For example, in the case of insurance policies, the policy premium is determined by the actuarial risk of the customer, supplied by the actuarial models of the insurance company; and the specific gross margin required by the service provider. In this case the consumer only knows the price of the product or service offered to him, and not its breakdown into cost and margin. In an industry such as insurance, where the cost (actuarial risk) of the product or service is individualized, the consumer only knows the price quoted to him and is practically unable to compare it with the price of an identical product offered to somebody else.
A methodology for setting enterprise pricing is disclosed in U.S. Pat. No. 6,308,162, which discloses the collection of sales data and its automated optimization in the light of primary enterprise objectives such as maximization of profit and using secondary objectives such as retaining a certain market share. The methodology produces an overall result such as an optimal store price for a given product but is not intended for providing individual pricing.
Products such as insurance policies are not products that are sold once only, neither are they products that have a fixed price for all consumers, but rather are products that are renewed on a regular basis. Yet no automated methodology currently exists for taking renewal business into account in setting an optimal price. Furthermore no automated methodology exists for providing individualized pricing.